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November 1, 2018 SEP Dev

What is the Mortgage Stress Test?

Are you annoyed with this term yet – the ‘mortgage stress test’? The mortgage stress test has been the talk of the town ever since January 1st, 2018 which is when the rule first came into effect, and boy did it cause confusion among home owners and even industry professionals. The media doesn’t do a great job of explaining what this mortgage stress test is, nor do the banks, so I took the liberty of simplifying, what should otherwise be, a fairly straightforward concept.

What is the mortgage stress test?

The mortgage stress test is a rate (also referred to as a benchmark rate). The stress test rate is currently the higher of either 5.34% OR the posted rate +2%. All banks are now required to use this rate to qualify you for your mortgage request – in other words, regardless of your mortgage request size ($100,000, $200,000… $700,000, etc.) you must be able to afford the mortgage at a rate of 5.34%. To be very clear, this does not mean you will be paying your mortgage based on 5.35%, rather you need to be able to afford the mortgage you are requesting as though the rate was indeed 5.35%, even if the rate is actually, let’s say, 3.54%.

How does the mortgage stress test impact me?

Simple answer… affordability. If you were seeking out a mortgage at your absolute maximum affordability prior to January 2018, then the mortgage stress test will certainly have an impact on you. What the mortgage stress test does is inflate your debt servicing ratios, thus decreasing your purchasing power by up to 20%. If in 2017 you were able to afford a mortgage upward to $500,000, today you might fall along the lines of only $400,000. That’s a big difference! If you never intended on applying for a mortgage at the very brink of your affordability (ex. You were looking for a home well under your maximum affordability), then thankfully the mortgage stress test should not put a halt to your plans. If you were pre-approved under the old rules, unfortunately that mortgage pre-approval may now be null in void.

Is there a way to get around the mortgage stress test?

All banks are required to use the mortgage stress test on all new applications as of January 1st, 2018, regardless of whether you are putting >20% down and regardless of whether you are purchasing or refinancing (one of the notable differences from 2017-2018). So, if you were able to afford a maximum mortgage of “X” amount in 2017 and had expectations of buying onward, you will need to readjust your numbers to account for the decrease in affordability as a result of the new mortgage stress test regulations. Currently only Credit Unions are exempt from the stress test regulations. If you have >20% down payment a Credit Union will likely offer a higher mortgage approval than traditional banks. If you have <20% down, Credit Unions will not be an option.

What is the main reason for the mortgage stress test?

Does the stress test stink? Absolutely. Is there a deeper rooted advantage to the test? Economically speaking, yes there is. The implementation of the stress test was due to historically low rates (as they can only go up from where they sat for several years) and to be quite honest… people were getting in over their heads (specifically consumer household debt). It might not be apparent to someone who is currently in the market to buy, as the mortgage stress test to them is merely an annoying mosquito buzzing in the ear, but in the grand scheme of things it’s a precautionary measure to protect our entire economy. Market stabilization is important for our future, and with the way things were trending in 2017, we were heading into the red danger zone.  Since we can’t change the rules, I guess we’ll just need to remember that there is an upside that we all benefit from.